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Michigan Supreme Court Clarifies Direct vs. Derivative Claim Standard in Murphy v. Inman

Written by Zana Tomich on May 17, 2022 Category: Business Law & Transactions, Commercial Litigation, Shareholder Disputes

When a corporate shareholder alleges harm due to acts or omissions by corporate officers and directors, the question of whether the shareholder must bring a “direct” or “derivative” claim often arises.

A direct claim asserts that the defendants harmed the shareholder. Derivative claims, on the other hand, assert that the defendants harmed the corporation itself, and the shareholder steps into the corporation’s shoes and seeks restitution on its behalf. One of the most significant consequences stemming from the direct/derivative dichotomy is that damages recovered in a derivative suit belong to the corporation, while damages in a direct action belong to the shareholder.

It hasn’t always been easy in Michigan to determine whether claims may be made directly or only as derivative claims. However, in the recently decided case of Murphy v Inman, the Michigan Supreme Court clarified the analysis while holding that a shareholder who alleged that corporate directors breached their fiduciary duty in approving a cash-out merger was entitled to bring that claim as a direct shareholder action.

The Murphy v. Inman Decision

In this case, a shareholder of Covisint Corporation brought suit against the company’s directors—a direct claim. The shareholder alleged that the company’s directors breached their fiduciary duties by failing to maximize shareholder value during a cash-out merger transaction.

The defendant directors successfully sought dismissal of the case in the trial court, arguing that the shareholder’s claims were derivative and, accordingly, could only be brought by complying with the derivative claim procedures in Michigan’s Business Corporation Act (“BCA”). The Michigan Court of Appeals affirmed the trial court’s decision.

The Michigan Supreme then reversed, holding that the claim could be brought as a direct claim.

Drawing upon Delaware corporate law, the court boiled down the direct or derivative test down to two key questions: first, whether the corporation or the individual suffered the alleged harm, and second, whether the corporation or the individual would receive the benefit of any damages or other remedy awarded by a court. Previously, Michigan courts adhered to a “general rule” that assumed that claims belong to the corporation and thus must be brought by a shareholder derivatively unless certain exceptions applied.

While the court ruled that the shareholder’s claim could be brought as a direct claim, and clarified and simplified the standard for determining whether a claim is direct or derivative, it did not go so far as to decide whether Covisint’s directors’ violated their fiduciary duties.

The court also clarified in this case that directors of a corporation owe fiduciary duties to shareholders of the corporation. The defendant directors in this case argued that Section 541a of the BCA provides that directors owe fiduciary duties only to the corporation and not shareholders. But the court held that Michigan law has consistently recognized that directors owe fiduciary duties to shareholders, and that nothing in Section 541a changes that.

The court explained that, in a sale process such as the one involving Covisint, a director’s duties include trying to get the best possible price in a sale for the benefit of shareholders.

Implications of the Decision

Corporate directors and shareholders now have a clearer understanding of the distinctions between direct and derivative actions, as well as the scope of a corporate director’s fiduciary duties, in the wake of the Murphy v. Inmandecision.

Among other things, this will help business lawyers counsel corporate clients on the relative benefits and risks of taking, or not taking, certain actions in various situations such as in the midst of negotiating corporate transactions.

And while this case deals with corporations under the BCA, it’s reasonable to assume that the court’s ruling will be relevant in evaluating actions taken in connection with other corporate entities, such as LLCs, in Michigan.

If you have any questions about Murphy v. Inman and its potential impact on your business, please contact Zana Tomich.

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